Taking Stock Kudzanai Sharara
Following the introduction of SI 142 of 2019 and the subsequent exchange control directive RU102/2019 from the Reserve Bank of Zimbabwe, the country’s foreign exchange rate has to a large extent converged with the official exchange rate now more or less that of the parallel market or vice versa.
This, to some extent, is what the authorities have always wanted, to eliminate the parallel market and have the interbank market oversee currency trading in the country.
This major policy shift was in line with market demands. A few weeks ago Zimbabwe’s major industries lobby group, the Confederation of Zimbabwe Industry (CZI) called for a free forex market. The lobby group argued that the system, where foreign currency was mainly sourced on the parallel market at very high interest rates was not sustainable.
It is a threat to re-dollarisation and rapid depreciation of the RTGS dollar, CZI said.
As we now know, Government obliged to market demands and in the process abandoned the multi-currency system in favour of a mono-currency, the Zimbabwean dollar, currently represented by the bond notes and the RTGS dollar.
“. . . With effect from June 24, 2019, the British pound, United States dollar, South African rand, Botswana pula and any other foreign currency whatsoever shall no longer be legal tender alongside the Zimbabwe dollar in any transactions in Zimbabwe.
“Accordingly, the Zimbabwe dollar shall, with effect from June 24, 2019, but subject to section 3, be the sole legal tender in Zimbabwe in all transactions,” reads SI 142 of 2019.
As the doctor ordered, the move has largely resulted in the convergence of rates between the parallel market and the formal interbank market. As of Thursday this week, the interbank rate was at 8,5857 to the dollar, while rates on the parallel market were within that range.
Unfortunately, the direction the rate is taking is a cause for concern. The local currency has continued to weaken with the interbank rate in some banks much higher than what is prevailing on the parallel market. The idea I would like to believe was not only to eliminate the parallel market, but to also bring stability to the exchange rate.
A falling local currency was making all products with an import component expensive to the local consumer. Inflation reached 98 percent in May, and is likely to be much higher in June and the biggest driver has been a falling exchange rate, which meant more local dollars where needed to bring in imports.
Since the measures were announced on June 24, 2019, one now needs $8,5857 to buy US$1 as opposed to $6,3107 needed before SI 142 was announced. The parallel market rate might have come down from US$1:$15, but the trajectory the formal one is taking is a cause for concern.
Following the fall of the parallel market exchange rate, consumers are waiting for prices to come off. Some are already falling. Businesses are also contemplating reducing prices. But with the official exchange rate moving northwards, that decision might be postponed to a future date, if ever.
A rapid movement of the exchange rate does not inspire confidence but brings uncertainty. If it continues on that trajectory even businesses that had reduced prices might start reconsidering that decision.
Volatile exchange rates make trade and investment decisions more difficult because volatility increases exchange rate risk. Before we look at what needs to be done, we need to look at what is causing the rate to continue on a weakening path.
It’s early days, so confidence is yet to build and this might take a little bit of time.
Holders of foreign currency have adopted a wait-and-see attitude and are selling very little.
Demand on the formal market has increased but availability is still subdued.
There is little to sale, as the retention thresholds are still very high.
What are the options?
If prices are to come down and inflation be tamed, the exchange rate has to stabilise at a reasonable level. The question, however, is whether the RBZ has the ammunition to manage the exchange rate as per international best practice.
One way that is used the world over is that of raising or reducing interest rates to make the exchange rate stronger or weaker. In the US, the Federal Reserve when it puts up interest rates, the US dollar strengthens, and the reverse is true when interest rates are lowered. Generally, higher interest rates increase the value of a country’s currency.
Higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country’s currency.
Last week the RBZ announced a significant hike in overnight window interest rates from 15 percent to 50 percent in an effort to manage the exchange rate, but with inflation rates at 98 percent, the hike might just be academic and might not do much to manage the exchange rate.
The exchange rate could have been managed through an injection of foreign currency into the system by the RBZ to meet the increased demand. More dollars would have removed the need to push up rates by buyers.
Again this move is a big ask for the central bank, which without any reserves resorts to borrowings for foreign currency. But with the lenders limited to just Afreximbank, the RBZ might not have the capacity to manage the exchange rate through injection of foreign currency.
Closing the current account gap is another option to manage the exchange rate. A deficit in the current account shows the country is spending more on foreign trade than it is earning.
Zimbabwe is currently a net importer of goods and services so forex demands are very high. The current account deficit can only be closed by increasing productions and consumption of local products from raw materials to finished products. But with production currently lower, this means demand for foreign currency will remain elevated for a little longer and the current account gap will not be closed in the short to medium term.
The most viable option at the moment is probably for the RBZ to remove all retention thresholds and go back to basics, were government gets taxes and duties and does not involve itself in procurement and allocation of forex.
According to consultations done by CZI, exporters are not actively participating on the interbank market chiefly because they are illiquid since they surrender 50 percent of foreign exchange earnings to the Reserve Bank of Zimbabwe (RBZ). In recommendation, CZI suggest that there be 100 percent retention and automatic sale of export earnings.
“The key to lowering the exchange rate and bringing it closer to the equilibrium is to put mechanisms and measures in place, which result in an automatic monthly flow of foreign currency into the interbank market,” said the business lobby group.